Has the rally been engineered?

by Anthony Cherniawski, The Practical Investor, LLC | September 25, 2009

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A boutique investment house is “concerned” that banks may have been using their bailout money — and no doubt some of their quantitative easing-gained liquidity — to buy equities, thereby fuelling the summer rally. The danger, they say, is that this is a relatively “thin” rally — and one which is vulnerable if banks suddenly decide to pull out and monetize their gains.

“The banks have every right to use the money they borrow in any way they choose. But it would be good to know how much of the bailout money has been used to buy equities. Clearly, someone has been buying, and given that it hasn’t been ordinary investors and the institutions that  just leaves the banks. “The banks’ balance sheets will certainly have benefited from their equity holdings. If they could sell these investments into a rising market then they would be in a better position to repay their debts. But there will be a problem if the public and institutions do not join the rally and the banks have to sell equities into a vacuum.”

According to Meredith Whitney in a CNBC interview, “For fundamental investors you invest on what you know to be the rules of the market. With the government involved no rules of the market apply. … And things that I never imagined that I would see in my lifetime you’re seeing in terms of government intervention. So shorts covered because they couldn’t play, shorts covered after they lost a lot of money because they couldn’t play, and then the long-only guys are grossly underinvested and so they see the rally and they’ve got to reweight and so it’s a crazy positive momentum based on no fundamental improvement. Zero fundamental improvement.” 

Meanwhile, the FDIC has a decision to make: How to replenish its insurance fund. With failures mounting and banks complaining about fees, borrowing from Uncle Sam may be the best way out.

Is the rally over?

--Now that the stock market has moved over 50% higher in the past 6 months, there are two words that would best describe where we are now: "mission accomplished". Of course, we all remember President George W. Bush in the early months of the Iraq War standing on the deck of a Navy ship with those two words emblazoned on a banner in the background. Little did we know, that "mission accomplished" really meant mission just getting started.
Is the Fed scaling back?

-- The Federal Reserve and U.S. Treasury said they’re scaling back emergency programs aimed at combating the financial crisis, reducing support for firms that now have an easier time getting funding. The central bank today said it will further shrink auctions of cash loans to banks and Treasury securities to bond dealers, reducing the combined initiatives to $100 billion by January from $450 billion. The Treasury has “begun the process of exiting from some emergency programs,” the chief of the government’s $700 billion financial-rescue fund said separately.

 Gold suffers a turnaround.

--Gold is headed for its biggest weekly decline since July as the dollar strengthened on signs that global leaders will act to stabilize global financial markets, boosting demand for so-called haven currencies. The recent sideways movements suggest some market fatigue and traders recognize that the dollar is rebounding from its weakness.

 
Japanese stocks losing their grip.

-- The Nikkei 225 Stock Average slid 2.6 percent to close at 10,265.98 in Tokyo. The broader Topix index lost 2.9 percent to 922.67, the sharpest dive since June 16. Eight stocks dropped for each that rose and all industry groups on the Topix fell.
For this holiday-shortened week, the Nikkei dropped 1 percent, while the broader index lost 1.8 percent. Markets were shut Sept. 21 through Sept. 23.

China is approaching bear market territory…again.

-- The Shanghai Composite Index fell, with the Shanghai Composite Index completing its biggest weekly loss in six weeks, as commodity prices slumped and investors speculated rising stock supply will divert funds from existing equities. The benchmark index fell 14.71, or 0.5 percent, to 2,838.84 at the close, its lowest close since Sept. 2. It lost 4.2 percent this week, the most since the five days to Aug. 14, when it dropped 6.6 percent.
Is the dollar reversing from the bottom?

-- The dollar advanced for a third-day against the euro, the longest strength of gains in a month, as signs of a slow recovery from the recession reduced demand for higher-yielding assets funded in the greenback.                                    The dollar headed for its first weekly advance in three weeks against the 16-nation currency before a report forecast to show that growth in U.S. durable goods orders slowed last month.

Housing stimulus winding down.

-- The crash in U.S. home prices will probably resume because about 7 million properties that are likely to be seized by lenders have yet to hit the market.                                     The “huge shadow inventory,” reflecting mortgages already being foreclosed upon or now delinquent and likely to be, compares with 1.27 million in 2005. Assuming no other homes are on the market, it would take 1.35 years to sell the properties based on the current pace of existing-home sales, they said.

Oil inventories are building.

The Energy Information Administration Weekly Report suggests that, “For the sixth week in a row, the U.S. average price for regular gasoline decreased. The average dipped two and a half cents to $2.55 per gallon, bringing the cumulative drop for the past six weeks to nearly 10 cents. The national average was $1.17 less than a year ago as prices fell in all regions of the country.”  Oil inventories are building.

Economic recovery…or manipulation?

The Energy Information Agency’s Natural Gas Weekly Update reports, “Natural gas spot prices increased on the week at all market locations, except for a few trading points in the western half of the country. Increases ranged between 2 and 23 cents per MMBtu, although a majority of the trading locations saw prices rise by 12 to 18 cents on the week.” 

 

Why aren’t banks foreclosing?

Banks don’t care about home prices. They care about not losing money. Because the government changed mark-to-market accounting rules, the link between low prices and losing money is broken.

Banks make more money by NOT foreclosing on homes. Banks are dragging out the foreclosure process for their own selfish reasons. Until the day they foreclose, the amount of money owed to them is an asset…sure, it’s an asset that isn’t paying interest payments…but it is still an asset. The day they foreclose, a $400,000 asset could become a $150,000 asset and a $250,000 loss.

Multiply that loss by 10, 20, or even 30 times leverage and there are several million dollars worth of new loans that the bank can’t make.  Faulty government programs and doctored accounting rules have produced the fiasco before us: There are roughly 4 million homes that should be foreclosed on but they won’t be any time soon. This enormous can is continuing to get kicked down the road.

Julian Robertson discusses U.S. debt and outlook for the economy.

To those who are relatively new to the investing game, Julian Robertson may not be a household name. After all, he returned all the capital his firm managed back to investors in 2000. But the founder of Tiger Management had an incredible 20-year run prior to that point and in short, is a legend in the hedge fund industry. Thus, when Mr. Robertson talks, those that have been around a while definitely listen.

You may wish to view his CNBC video here.

Copyright © 2009 Anthony Cherniawski
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Anthony Cherniawski | President and CIO, The Practical Investor, LLC. 
State Registered Investment Advisor | Mason, MI USA | Email | Website

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